The Breakdown - Macro Signals Are All Flashing Warnings

Episode Date: October 6, 2023

What the hell is going on with bond markets? Why are people buying less food? Is the Fed priced into more rate hikes? NLW explores all of this and more. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. What's going on, guys? It is Friday, October 6th, and today we are talking about the just unbelievable variety of deteriorating economic indicators. Before we get into that, however, if you were enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. Find a link at the show notes or go to bit.ly slash breakdown pod. All right, friends, welcome back to the breakdown. No updates on FTX today. As I am recording this, Gary Wang, the CTO and co-founder of FTX is on the stand.

And I will say only that if Adam Yadidia's testimony yesterday didn't look good for Sam, Gary's testimony yesterday and today looks even worse. I will quote from Matthew Russell Lee at Inner City Press on Twitter, who is, by the way, the single best person to follow for play-by-play coverage of this. the attorney asks Gary, did you commit crimes at FTX? Gary responds, yes, with Nashad Singh, Carolyn Ellison, and Sam Bankman-Fried. Rough.

But what we're actually talking about today is the fact that outside our little corner of the economic world, basically every indicator is going to hell. Summing it up, Arthur Hayes says it's about to be Rectober. So let's start with bonds because that's what everyone's talking about. A massive sell-off is underway in the long end of the U.S. Treasury market. The yield on the 10-year Treasury note touched 4.8% on Wednesday, while the 30-year note breached 4.9% briefly. Both are marks that haven't been seen since early 2007.

TLT, the ETF, which tracks the price of a basket of long-term bonds with maturities over 20 years, has continued its multi-year drawdown. The most recent leg has seen over 15% of value wiped out in long-term bond investments since July. TLT has now lost almost 50% of its value since the top in July 2020. By way of comparison, the 2008 crash saw 57% collapse in the S&P4. 500 across two years, while the dot-com crash of 2001 featured a 50% decline in the S&P. The losses accrued during the current bond market route are twice as large as those during the bond collapse of 1981, when the Paul Volker Fed hiked the interest rate to almost 20%.

Now, no, TLT is not a small ETF. It's one of the top 30 ETFs in the world in terms of assets under management, about a tenth of the size of the SPY SMP 500 index ETF. Now, interestingly, although TLT has been getting pummeled, traders continue to flock in. The ETF has seen $33 billion in inflows since the Fed began hiking rates in March 2022. More than half of inflows have come this year. Assets under management have more than doubled despite the aggressive drawdown in price per share. As ETF store president Nate Garasi put it,

TLT has been a quote, cash incinerator. So what's causing this huge flow of funds into a collapsing bond market? TLT represents just one part of a massive collection of interconnected markets exposed to price action in U.S. treasuries. So it's impossible to know all of the positions being taken just by looking at one ETF. Part of the increased demand for treasuries comes from asset managers running fixed income portfolios. For example, pension funds, insurers, and bank balance sheets are some of the major investors who hold long-term treasuries. A paper loss on bond investments isn't typically a big deal for pension funds and banks,

as long as they can continue to hold those positions to maturity. But, as we've seen repeatedly over the past few years, holding to maturity is not always possible. Now, although these structural buyers are part of the story, many believe they don't explain the large increase in volume for TLT. Eric Bacuna's senior ETF analyst at Bloomberg wrote in a Twitter post that TLT investments, quote, have cost traders $6 billion, but they keep coming back because it has to work. This is arguably the new fighting the Fed trade.

When asked if he thinks it's just portfolio rebalancing, Eric said. That could be part of it for sure, but based on the elevated volume, it would indicate its trader's betting. Now, one of the known bets being done in size is the basis trade. Basis trades in general are when an investor takes one position in spot markets offside by an inverse position in a derivative market to capture the price spread. In this case, hedge funds and other professional investors are taking long positions by buying bonds outright and then shorting futures. Short interest in U.S. Treasury futures is currently at all-time highs, recently exceeding their late 2019 peak. Importantly, a basis trade in U.S. Treasuries was widely blamed for the repo spike in September 2019.

This trade is generally seen as a cause of systemic risk due to the massive leverage involved and its location close to the heart of the global financial system. The Fed, the Bank of England, and the Bank for International Settlements have all recently published papers warning of the risks of this arbitrage trade, and noting its resurgence. Goldman Sachs, on the other hand, is much less worried. Publishing a note last week which stated, We do not think the trade poses a major risk to treasury markets in the near term. Leverage in the system is materially lower than it was in 2019, 2020, as a result of a series of initial margin increases and price declines.

Still, the BIS paper from last month said the basis trade, quote, is a financial vulnerability worth monitoring because of the margin spirals it could potentially trigger. Now, beyond the trade, some believe this price action is simply the bond market pricing in higher for longer. At last month's meeting, Fed officials stood firm in their hire-for-longer rate forecast. Markets, seemingly for the first time this hiking cycle, are actually listening. Nick Timrose, the Wall Street Journal's resident Fed whisperer, tweeted on Thursday, Is the Fed finally getting tighter financial conditions? He attached a quote from Dalip Singh, a former New York Fed official and now chief economist

at PGIM fixed income, which said, these types of things often take on a life of their own until they self-correct, either through weaker economic data or a more sinister mechanism such as a financial stability scare. Either of those two developments would mark an inflection point back towards lower yields, but were not there yet. Timmeros also noted that this is the first hiking cycle out of the past five, where the Fed has approached peak rates without seeing a collapse in longer-term bond yields. He wrote in a Twitter post, this time has been different. Investors had priced in and are now pricing out a recession, with a quick turn towards rate cuts. However, in an appearance on CNBC

earlier this week, Jim Bianco had a slightly different take on reactions to last month's Fed meeting. He said, what you're seeing in the bond market is a capitulation. Basically, most of the year, bond managers have been long in trying to argue why we're going to have a recession, why there's going to be a rally, and they've been having their brains beat in. If the Fed is done and the market senses there is still some inflation left, they don't want to touch bonds. I don't think the Fed cares about volatility in the bond market yet. They're asking the question, is it slowing growth in the real economy? Others noted that rates have hit a point where they are likely to cause a major problem for U.S. government financing. The Congressional Budget Office recently updated its forecast to note that interest expenses are set to reach

20% of tax receipts by 2032 if they remain on current trajectory. Economist Harold Momgren said, the rise in long rates is primarily being driven by the huge and growing U.S. budget deficit, added Jeffrey Gunlock of double-line capital, with these interest rates going up, we're facing a really big challenge that I'm sure the Fed is aware of and thinking of, but I think all investors should think about too, the growing interest burden. Now, former Bitmex CEO Arthur Hayes has published a new essay and has a strong view on how this bond market dysfunction ends. He argues that, quote, we are about to witness the biggest bull market in human history driven by the amount of money printed in the shortest amount of time. Hay's point is that the large

imbalances always resolve in one way. Printing money, he writes, is always the answer, forever delaying any adjustment to the architecture of the global trading and financial system. Now, this bond market route has had Arthur banging the table all week. He has been pointing to the current yield curve move, known as a bare steepener as basically unprecedented. A bare steepener is when long-term interest rates rise faster than short-term rates, uninverting the yield curve while keeping rates high across the board. Arthur explains, bank models have no concept of a bear steepener occurring. If the bank's models don't have it, then it is considered not a possible outcome and traders don't hedge. As the twos and 30s curve steepens alongside the two-year and 30-year rates rising,

fixed-income trading desks start bleeding money and can't figure out why. Due to the leverage and nonlinear risks embedded in bank's portfolios, they will begin selling bonds or paying fixed on interest rate swaps as rates rise. More selling begets more selling, which is no bueno for bond prices. The faster this bear steepener rises, the faster someone goes belly. up, the faster everyone recognizes there is no way out other than money printing to save government bond markets, the faster we get back to the crypto bull market. So that is some of the story in bonds, obviously. Not only could we talk about more, every cable news economic show is exclusively talking about that. But let's go to some other indicators in the macro economy as well. On Wednesday,

the ADP published their private payrolls report. The payroll processing firm said that job growth for September had come in way below expectations. It saw just 89,000 jobs added for the month. This was down from an upwardly revised 180,000 in August, and well below estimates of 160,000. This was the slowest job growth in the ADP figures since May 2020. ADP also said that annual wage growth had cooled to 5.9% the 12th consecutive monthly decline. Job gains came almost exclusively from the service sector, which saw 81,000 net jobs added almost entirely from leisure and hospitality. Major net job losses came from professional services, transportation, and manufacturing. Now, a lot of people said that this should give the Fed leave to continue its pause trajectory.

However, this morning we got the release of the non-farm payroll report, and it told a very different story. TLDR, September payrolls increased $33,000. The estimate had been $170,000. So basically, we beat it to the upside by double. That means that this indicator that Jerome Powell has been looking at for a year and a half, which is tightness in the labor market, is still incredibly tight, which frankly gives the Fed leave. and even potentially a mandate to increase rates even more. As Adam Cochran wrote,

well, poor one out for the soft landing, we're above the runway and adding on speed. The Fed is going to bring the hammer. In terms of GDP numbers, last week, the U.S. Commerce Department published its final revision of second quarter GDP, holding steady at a 2.1% annualized growth rate. Below the headline, the data showed a large downward

revision to consumer spending growth, from 1.7% to just 0.8% on an annualized basis. This is 80% lower than the consumer spending growth figure for Q1. Given that consumer spending accounts for around 70% of US GDP, the revision could speak to a troubling trend as the US consumer cuts back. Claire Lee, Vice President of Credit Strategy and research at Moody's Investor Service said, post-pandemic spending on deferred travel and experiences has increased yet, tighter budgets may prompt consumers to cut back on discretionary services spending, especially as services inflation remains sticky. Now, as an unconventional economic indicator,

outgoing Nestle's CFO Francois Xavier Roger had some troubling comments about the state of the global food market. He said that the total amount of food and drinks sold globally has been steadily falling since the beginning of the year. Roger said, people are consuming less, or they're eating less, or they're wasting less, or they're eating more out of home. It's difficult to know. Indeed, though many large consumer goods companies have grown sales throughout the year, the increase has been on the back of price rises, with many suffering a decline in volumes. Some pointed to, as a culprit, the recent adoption of new weight loss drugs. During an interview on Wednesday, the CEO of Walmart said, we definitely do see a slight change compared to the total

population. We do see a slight pullback in overall basket, just less units, slightly less calories. Now, while junk food purchases are unambiguously decreasing, many suggested the explanation is far more obvious and troubling than the adoption of weight loss drugs. Jeff Snyder tweeted, people now can't afford to eat. People are eating less and it's not a matter of choice. It's a symptom of a deepening crisis. Rising oil prices are a significant contributor to this problem. As oil prices surge once again, people are feeling the pain in their pockets. The situation is dire and it's about to get worse. The global economy has hit a wall. People are struggling to afford food, credit card debt is skyrocketing, and much more. What happened to the booming economy of just a

couple months ago? Contributing to this notion of the consumer economy running out of steam, in September, consumer delinquencies rose across the board. Auto loans, credit cards, and other consumer loan delinquencies have been steadily rising since late 2021 and have now reached decade-long highs. Credit card delinquencies are now at a little below 4%. And while that's nowhere near the 7% seen in 2009, we are also well past the last peak in 2020. Now, mortgage rates have also been spiking alongside the rapid increase in rates for long-term treasuries. The average for a 30-year fixed rate loan hits 7.49% this week, according to Freddie Mac. That's the fourth straight week of increases bringing the average rate to its highest level since December 2000. What's more, some

markets flashed rates above 8% late this week, indicating that there are no signs of mortgage rates slowing down. Sam Cotter, Freddie Mac's chief economist, said, several factors, including shifts in Inflation, the job market, and uncertainty around the Federal Reserve's next move are contributing to the highest mortgage rates in a generation. Unsurprisingly, this is pulling back homebuyer demand. Now, that lack of homebuyer demand has been met with a slowdown in new listings as homeowners stay put. New listings declined last week with this year exhibiting one of the lowest rate of home listings in recorded history. 2020 saw huge numbers of households refinancing into long-term loans at or below a 3% rate. For many households, that historically low mortgage rate has made selling a financial impossibility with new loan rates as high as they are.

So friends, that is the look at the macro. It is dicey out there. There isn't a lot of consensus about exactly what's going on. There is only consensus that it's getting worse, not better. Obviously, all eyes will be on Jerome Powell and the Fed and any indications that they give around their thinking is headed after this non-farm payroll report, and I, of course, will keep you updated as the picture becomes clearer. For now, I hope you are headed into a wonderful weekend in one of the best months of the year, and so until next time, be safe and take care of each other. Thank you.